Skew is dead, long live skew.

For the better part of two months, Nomura’s Charlie McElligott pointed to an apparent dearth of demand for downside protection to make the case that equity exposure among key investor cohorts wasn’t long enough to presage an escalatory drawdown for stocks.

Put differently: Flat skew/moribund put skew appeared to suggest that at least some investors were under-exposed (you don’t need to hedge what you don’t own), a message that was corroborated by steep call skew (you need upside optionality if you don’t have enough exposure on into a melt-up).

Crucially — and Charlie reiterated this on Thursday while recapping key points — steep skew is in some sense a prerequisite for a big crash to the extent a quick, acute drawdown is often accompanied by selling-begets-selling dynamics.

“You need steep/high skew as that then indicates dealers are in a ‘short downside gamma / short vega’ position into a spot selloff, which then makes for ‘accelerant flows’ from dealer hedging in futures that will feed the momentum of a downside break,” he said.

Well, skew has steepened a bit in light of upside macro surprises and the correction in Fed cut pricing off the recent dovish extremes.

Behind that, McElligott noted, is hedging flow tied to well-publicized VIX call-buying, a story all its own, albeit a related one (obviously).

The key point for general audiences is the interplay between this and the evolution of the macro-policy conjuncture or, perhaps more aptly, the non-evolution of that conjuncture: The macro refuses to roll over in the US, and as such, Fed officials can’t countenance anything more than the 75bps of token rate cuts tipped by the December dots even if they want to.

Consider that, then recall the discussion from Monday around how equities appear to lack a nuanced understanding of what market pricing for rate cuts actually shows. As I put it two days ago, ~150bps of “priced-in” rate cuts could mean any number of things. “It reflects a veritable constellation of prospective macro-policy permutations and, crucially, the odds traders assign to them,” I wrote.

So, what have we actually seen since late last week? We’ve seen around 25bps of cuts shaved off 2024 Fed pricing, a reflection of i) Chris Waller’s cautious remarks on the likely pace and timing for rate reductions, ii) an upside surprise on UK headline CPI, iii) a robust read on retail sales in the US and on Thursday iv) the lowest initial US jobless claims print since September of 2022 during an NFP survey week.

In his Thursday note, McElligott tied all of this together. Below, presented in his words and without further comment, is the summary version:

We’re witnessing a local counter-trend move in the US equities index options skew regime into January OpEx, which is largely a function of dealers hedging the massive and ongoing VIX call hedge demand, pushing us closer to an environment where you could actually get [a] ‘crash-down’ (although we aren’t quite there yet without a fresh downside catalyst). And what’s the genesis of this incessant demand for hedges via VIX calls? In my eyes, it’s the fact that this ‘incrementally hawkish’ data is persisting alongside recently ‘less dovish’ Fed rhetoric [which] is then seeing that ‘hard landing’–tail mode in the Fed cuts probability distribution lose delta [as] the data simply rejects [or] delays the large-magnitude Fed cuts path for 2024. In other words, as you go from the previously priced ~175bps of implied 2024 Fed cuts across the probability distribution instead to down closer to ~150bps of implied cuts, it’s a de facto ‘tightening,’ especially into the risk from further re-pricing lower of Fed cuts on [any] additional firming of the [macro], which is a risk after the massive multi-month FCI easing.